Foreign Exchange Market

Foreign Exchange Market

Foreign exchange (FOREX): the buying and selling of currency

• The exchange rate (e) is determined in the foreign currency markets
• Simply put. The exchange rate is the price of a currency

Tips

• Always change the D line on one currency graph, the S like on the other currency's graph
• Move the lines of the two currency graphs in the same directions (right or left) and you will have the correct answer 
• If D on one graph increases, S on the other will also increase
• If D moves to the left, S will move to the left on the other graph

Changes in exchange rate

-Exchange rates (e) are a fiction of the supply and demand for currency

• An increase in the supply of a currency will make it cheaper to buy one unit of that currency
• A decrease in supply of a currency will make it more expensive to buy one unit of that currency
• An increase in demand for currency will make it more expensive to buy one unit of that currency
• A decrease in demand for a currency will make it cheaper to buy one unit of that currency

Appreciation: appreciation of a currency occurs when the exchange rate of that currency increases 

Hypothetical: 100 yen used to buy $1

Depreciation: depreciation of a currency occurs when the exchange rate of that currency decrease

• One hundred ten used to buy now dollar. Now 50 yen buys one dollar
• The dollar is weaker because it takes fewer yen to buy one dollar

Exchange rate determinants

• consumer tastes
• relative income
• relative price level
• speculation

Purchasing power parity: when the current rates are set by international markets changes will be based on the actual purchasing power of the currencies

• For ex: if US dollar to European euro is $1.50 to 1 than each S1.50 will buy one euro however if an item in the U.S. cost $1.50, and then cost more or less than one euro, the parity is lost, markets will adjust quickly in floating rates or pressure for change will occur in fixed rates 

Why do we exchange currencies?

1. To invest in other countries stocks and bonds
2. Sell exports and buy imports
3. To build factories or stores in other markets
4. To hold currencies in ban accounts for future imports, exports, or business loans
5. Tp speculate on currency values
6. To control excessive imbalances and the imbalance will come from the balance of payment